May 3, 2006
SOCIAL
SECURITY AND INHERITANCE:
THE DUBIOUS PROMISE OF PRIVATE ACCOUNTS
By David Kamin and Jason Furman[1]
Executive Summary:
Inheritance is one of the least understood issues in the Social Security
debate. Supporters of private accounts often cite the ability to pass an
account on to one’s heirs as an especially attractive feature of private
accounts, one that the traditional Social Security system cannot match. For
example, in making the case that private accounts are “a better deal” than
traditional Social Security, President Bush said in his 2005 State of the Union
address that, with a private account, “you’ll be able to pass along the money
that accumulates . . . to your children and – or grandchildren.”
Careful
analysis shows, however, that this is a dubious and overblown promise, for
several reasons.
First,
Social Security already provides an inheritance benefit in the form of survivors
benefits, which account for nearly one-fifth of all benefits that Social
Security pays. When a worker dies, Social Security pays survivors benefits for
a number of years to the worker’s minor children as well as to the worker’s
spouse if the spouse is raising children who are under 16 or the spouse is 60 or
older.[1]
The Social Security actuaries have reported that for a typical family with two
young children in which a worker dies before reaching retirement age, the
survivors benefits can be the equivalent of inheriting $400,000, a much larger
sum than most workers could accumulate in a private account.
Second, a
number of the leading private-accounts plans include substantial reductions
in Social Security survivors benefits or in other Social Security benefits that
surviving spouses would receive. Because of the way in which Social Security
benefits for many surviving family members generally are structured under
private-account plans, many surviving family members would receive significantly
smaller Social Security benefits than under the traditional Social Security
system. These reductions in Social Security benefits for surviving family
members often would exceed the size of the private accounts these
survivors would inherit. That would leave surviving family members with a
smaller inheritance overall than they would obtain under the current
system.
Three
principal groups (which are not mutually exclusive) of surviving family members
could end up with net reductions in inheritances under the leading
private-accounts plans:
-
Minor children and widows (or widowers) of deceased
workers whose Social Security survivors benefits would be reduced by more than
the private-account balances they could inherit. Various private-accounts
proposals, including the President’s, contain substantial reductions in
survivors benefits, as part of a broader set of benefit reductions designed to
help close Social Security’s long-term funding gap. These benefit reductions
generally would be far larger than the private-account balances that many
survivors could inherit. As a result, these survivors’ overall inheritances
would effectively be reduced, and many vulnerable survivors would be worse off
than under the current system.
-
Widows who inherit not only the deceased worker’s private
account but also the debt that the worker owed to Social Security as a
result of having elected an account. Under most private-accounts plans,
workers who opt for a private account must give up a portion of their
traditional Social Security retirement benefits in exchange for a private
account. This benefit reduction repays Social Security for the money deposited
in these accounts (plus interest), reflecting the fact that this money would
otherwise have remained in the Social Security Trust Fund. (This benefit
reduction would be in addition to any benefit reductions made to help restore
Social Security solvency.)
If a worker died before
retiring, the worker’s spouse would inherit not only the worker’s private
account but also the debt that the worker owed to Social Security as a result of
having elected an account. The spouse’s own Social Security retirement benefits
would be reduced by the amount necessary to repay that debt. (A surviving
spouse also would be subject to these reductions in her own Social Security
benefits if her husband died after retiring if her Social Security
retirement benefits were based on his earnings record rather than her own.)
Both the President’s plan and the Social Security plans proposed by Senator
DeMint and Congressman McCrery contain this provision.
Under the President’s plan, if the deceased worker’s account earned less than
about 5.5 percent a year on average (less than 2.7 percent above the inflation
rate), the surviving spouse’s Social Security retirement benefits would be
reduced by an amount larger than the size of the worker’s account, and
the spouse would be worse off. The risks inherent in replacing guaranteed
Social Security benefits with private accounts that rise and fall with financial
markets would thus affect the well-being of large numbers of widows, including
widows who had not elected a private account themselves.
-
Heirs of retirees who lived to a very old age.
Social Security pays benefits for as long as a retiree lives, and people who
live to a very old age consequently receive considerably more in total benefits
than people who die younger. Substituting a private account for a portion
of an individual’s Social Security benefits would undermine this aspect of
Social Security and tend to have a negative result for people who live to a very
old age.
There
are two factors at play. First, private accounts, unlike Social Security,
would not provide more in total benefits to a retiree who lives for many
years than to a retiree who lives for only a few years (unless the account has
been converted to a life-long annuity). This is because a private account
contains a fixed amount of money.[2]
Second, under the leading private-account plans, retirees who elected a private
account and then lived to a very old age would be subject to much greater total
reductions in their Social Security benefits than retirees who
died earlier. If a worker elected a private account, his or her Social Security
retirement benefits would be reduced (to repay the worker’s debt to Social
Security) every month for as long as he or she lived. The longer such an
individual lived, the larger the overall reductions in his or her Social
Security benefits would be.
Because of this, many retirees who elected a private account and then lived to a
very old age would have significantly less total income over the course of their
retirement than if they had not elected an account. To make up for these
losses, they generally would need to consume more of their savings. That, in
turn, would leave them with less money to pass on to their heirs. In some
cases, they might be forced to ask relatives to help support them in their final
years.
Heirs of many other retirees would not suffer net losses in inheritances
under private-account plans but would not see large gains either. For retirees
who lived to about an average life expectancy, private accounts would be
likely neither to increase significantly nor to decrease significantly the
amounts passed on to heirs.
The only groups of heirs who would consistently come out well ahead under
private-accounts plans would be the heirs of workers who died at a younger than
average age — either before or shortly after retiring — but only if they
inherited the account without being required to repay the debt the
deceased worker owed to Social Security.[3]
Effect on Social Security Solvency
To the extent that adoption of a private-accounts system led to an increase in
the total amount of inheritance benefits received by heirs as a group,
this would signify that some of the money that had been diverted from Social
Security to private accounts had not been repaid, leaving the Social Security
system with a net loss. Some resources that otherwise would have remained in
the Social Security Trust Fund would have been passed to heirs instead. To
prevent Social Security’s financing hole from expanding, these added inheritance
benefits would have to be paid for — through deeper cuts in Social Security
benefits or larger increases in taxes than otherwise would be needed. As
elsewhere in public policy, there is no free lunch here.
These issues
and findings are examined in more detail below.
I. How the Current System Provides Inheritance Benefits
The
Social Security system provides benefits to the survivors of deceased workers.
Social Security paid $88 billion in survivors benefits in 2004, which
represented 18 percent of all Social Security payments.[4]
These payments are currently made to 6.7 million survivors, including 1.9
million children.[5]
Survivors
benefits serve as a life insurance system: they ensure that some of the most
vulnerable survivors receive a basic level of income after a worker’s death.
Survivors benefits also are targeted, in that they provide more generous
benefits to families that have more children and also provide benefits when the
benefits are needed most — when children are young or disabled and when spouses
are 60 or over and thus less likely to be able to work. Monthly survivors
benefits are paid to a deceased worker’s family if there are children who are
under 18 or disabled (or children age 18 who are attending high school full
time), to a deceased worker’s spouse if the spouse is 60 or older or is caring
for a child who is younger than 16 or disabled, and to other groups as well.
[6] Survivors benefits are tantamount to an
inheritance that is passed down, through the Social Security system, from the
deceased worker to his or her dependent children and spouse.
Survivors benefits can be
extremely valuable to families of deceased workers. In an analysis issued in
2001, the Social Security actuaries estimated that survivors benefits for a
family with two young children are worth $403,000 if the deceased worker earned
average wages.[7]
The actuaries projected that for such a family, the Social Security
survivors benefits that the family would receive over the years would be the
equivalent of receiving an immediate inheritance of $403,000 when the worker died.
II. How Private
Accounts Plans Would Reduce Inheritances for Many Surviving Family
Members
For many surviving family
members, private-account plans would reduce inheritance benefits rather than
increase them. Private-account plans would tend to reduce inheritances for
three groups of survivors.
-
Under private-account plans that include substantial
reductions in Social Security survivors benefits, many minor children and widows
(or widowers) of deceased workers would be worse off, because the reductions in
their survivors benefits would far surpass the account balances that they could
inherit.
-
A second group of surviving family members whose inheritances
could be reduced consists of widows (or widowers) who would inherit a private
account that had not performed well in the stock market and who would have to
repay Social Security for the debt associated with that account. To repay the
debt, these widows’ own Social Security retirement benefits could be reduced by
more than the amount they would receive by inheriting the account.[8]
-
The third group consists of the heirs of retirees who live to a
very old age and, as a result, have their Social Security benefits reduced by
more than the amounts they receive from their private accounts. These retirees
often would have to dig deeper into their own savings to support themselves in
very old age, leaving them with less to pass to heirs.
The
following sections of the analysis examine each of these three groups.
1. Surviving Family Members Who Would
Face Large Reductions in Survivors Benefits
Many private-account plans
contain large reductions in Social Security benefits, including survivors
benefits, to help restore solvency. For example, the President’s plan includes
“sliding-scale benefit reductions” (also referred to as “progressive price
indexing”). These reductions would affect survivors benefits along with
retirement benefits. These reductions ultimately would result in rather
sharp benefit cuts for the majority of people who qualify for survivors
benefits.
-
Under the
President’s plan, the surviving family members of such a worker would face a
reduction in their Social Security survivors benefits of $7,950 a year (in
today’s dollars) if the worker died in 2045, and a reduction of $17,820 a year
if the worker died in 2075. The families would lose a total of $124,800
and $270,100, respectively, in survivors benefits over the years they
received these benefits.[10]
These would represent reductions in their Social Security survivors benefits of
18 percent and 29 percent, respectively. (See Table 1.)
TABLE 1
Proposed Sliding Scale Benefit Reductions
(Reduction for Surviving Family with Two Young Children)* |
Average Earnings of
Deceased Worker and Year of Death** |
Annual
Dollar Reduction
(in 2005 dollars)
|
Total
Dollar Reduction
(net present value)
|
Percentage Reduction*** |
Earnings of $36,600 |
|
|
|
Worker dying in 2045 |
-$7,950 |
-$124,800 |
-18% |
Worker dying in 2075 |
-$17,820 |
-$270,100 |
-29% |
|
|
|
|
Earnings of $58,560 |
|
|
|
Worker dying in 2045 |
-$15,010 |
-$236,900 |
-26% |
Worker dying in 2075 |
-$33,700 |
-$513,500 |
-43% |
|
|
|
|
Earnings of $90,000
or more |
|
|
|
Worker dying in 2045 |
-$23,730 |
-$374,700 |
-31% |
Worker dying in 2075 |
-$53,160 |
-$809,800 |
-51% |
|
|
|
|
|
Notes: * Includes the value of reduced benefits for the surviving widow and
two dependent children, consistent with the Social Security actuaries’
example (see footnote 6). As in the actuaries’ example, the estimates
assume that the workers are steady earners.
** The
earnings levels in the table are given in today’s terms. Over time,
workers’ earnings are assumed to grow at the same rate as average wages.
*** The
percentage reductions in survivors benefits shown here are slightly higher
than the percentage reductions in retirement benefits (as reported in other
CBPP papers) for people who retired at age 65 in the same year. Under the
proposed sliding-scale benefit reductions, the percentage reduction in
benefits is based on the year that a beneficiary becomes eligible for Social
Security. Retirees are first eligible to receive benefits at age 62. Thus,
the percentage reduction in newly awarded survivors benefits in any year
would be the same as the percentage reduction in retirement benefits for
people who began to draw those benefits at age 62 in the same year. This
percentage reduction would be slightly larger than the percentage reduction
in benefits for people who began drawing retirement benefits at age 65 in
that year.
Sources:
Authors’ calculations based on Social Security
Administration, Office of the Chief Actuary, “Estimated Financial Effects of
a Comprehensive Social Security Reform Proposal Including Progressive Price
Indexing -- INFORMATION,” February 10, 2005 and Social Security Trustees, 2004 Annual Report, March 2005
|
-
Many low-income survivors would be among those subject to
these cuts. As long as a deceased worker had average annual earnings of at
least $20,000 in today’s terms, the survivors benefits that would be paid to the
worker’s children and spouse would be reduced, regardless of how low the incomes
of the children and spouse had fallen after the worker’s death. It is common
for many spouses and children who are not poor while the family’s breadwinner is
alive to suffer sharp drops in income, and to fall into or close to poverty,
after the breadwinner dies.[11]
For many surviving spouses and children, private accounts would not come close
to making up for these large reductions in Social Security survivors benefits.
Table 2 shows the value of a private account for a deceased worker who has been
employed for ten years before dying and who leaves behind a spouse and two young
children. It compares the value of the private account that would be
passed on to the worker’s family with the reduction in survivors benefits to
which the family would be subject under the President’s plan.
-
If the worker earned an average of $36,600 in today’s terms (the
current average wage) for ten years and died in 2045, the worker’s private
account would be worth about $25,100.[12]
If the worker were employed for five years before dying, the account would be
worth a little less than half that amount. In either case, the account balance
would be dwarfed by the $124,800 in lifetime reductions in Social Security
survivors benefits to which the surviving family members would be subject under
the President’s proposal. The survivor’s family would be worse off by $99,700,
even before taking into account the additional Social Security benefit
reductions (described below) to which the surviving spouse could be subject in
order to repay her deceased husband’s debt to Social Security.
TABLE 2
Sliding
Scale Benefit Reductions and Private Accounts:
Net Effect on Survivors’
Inheritances
(For surviving
family with two young children in which the worker dies
after contributing to a private account for ten years)* |
Average Earnings of
Deceased Worker and Year of Death** |
Cut in Survivors
Benefits (Reduction Over Lifetime) |
Value of Private
Account at Worker’s Death |
Net Financial Effect
on Survivors (Over Lifetime)*** |
Percentage Reduction
in Inherited Benefits |
Earnings of $36,600 |
|
|
|
|
Worker dying in
2045 |
-$124,800 |
$25,100 |
-$99,700 |
-13% |
Worker dying in
2075 |
-$270,100 |
$34,700 |
-$235,400 |
-25% |
|
|
|
|
|
Earnings of $58,560 |
|
|
|
|
Worker dying in 2045 |
-$236,900 |
$40,200 |
-$196,700 |
-22% |
Worker dying in 2075 |
-$513,500 |
$55,400 |
-$458,000 |
-39% |
|
|
|
|
|
Earnings of $90,000
or more |
|
|
|
|
Worker dying in 2045 |
-$374,700 |
$58,100 |
-$316,500 |
-26% |
Worker dying in 2075 |
-$809,800 |
$84,800 |
-$725,000 |
-46% |
|
|
|
|
|
|
Notes: * Includes the value of
reductions in benefits for the surviving widow and two dependent children,
consistent with how the Social Security actuaries calculated the current
value of survivors benefits for such a family (see footnote 6).
Following the actuaries’ methodology, the estimates assume that the workers
are steady earners. All figures are in 2005 dollars and are expressed
in present value as of the worker’s death.
** The earnings levels in the
table are given in today’s terms. Over time, workers’ earnings are assumed
to grow at the same rate as average wages.
*** The reduction in
survivors benefits, in present value terms, can be compared to the value of
the private account at the time of the worker’s death.
Numbers may not add due to
rounding.
Source: Authors’ calculations.
|
-
In subsequent decades, the reduction in survivors
benefits would grow still larger and leave such families further behind.
The President’s proposal would reduce survivors benefits by $270,100, or 29
percent, for a family with two young children in which the worker earned
average wages and died in 2075. If such a worker were employed ten
years, his or her private account would be worth about $34,700 when the worker
died. In this case, the family would be worse off by $235,400. (As
Table 2 indicates, the reductions in survivors benefits would be still larger
for survivors of workers with higher earnings levels.
-
Other types of survivors also would be subject to
these losses, including elderly and adult children with disabilities.
(If children become disabled before age 22, they receive Social Security
survivors benefits throughout their lives.) For many of these survivors
as well, the value of a private account would be heavily outweighed by the
reductions in survivors benefits under plans such as the President’s.
It should be noted that these examples
understate the reduction in well-being for many surviving families under
private accounts, because the examples do not reflect another key feature of
leading private-account plans. Under the President’s plan, the DeMint and
McCrery plans, and various other plans, if a worker dies before retiring, the
surviving spouse, in many cases, would inherit not only the worker’s private
account but also the reduction in Social Security retirement benefits to which
the worker would have been subject in order to repay Social Security for the
diversion of revenues to his account. This aspect of private-account plans
and its effect on inheritance benefits is discussed next.
2. Surviving Spouses Who Would Inherit the Deceased Worker’s “Debt” to Social Security, As Well as the Worker’s Account
A second group of
surviving family members who could be made worse off under a number of the
leading private-account plans — i.e., whose inheritances could essentially be
reduced by these plans — are survivors who would inherit the deceased worker’s
debt as well as his account. Under most private-accounts plans, the widows (or
widowers) of workers who died before retiring would inherit not only the
deceased spouse’s account but also the debt associated with that account.
If the investments made with the private account performed poorly in the market,
the widow could be left with a debt that was larger than the value of the
account she inherited. For this reason, private accounts could represent a
risky gamble for many widows.
To
understand this point, some background on how many private-accounts plans would
work is in order. The leading private-account plans all impose a “benefit
offset” on workers who elect private accounts. A worker who elects an account
would essentially take out a loan from the Social Security Trust Fund; a
portion of the worker’s payroll taxes would essentially be loaned from the
Social Security Trust Fund to the worker’s private account. The worker would
then owe this money back to Social Security, with interest. Under the
President’s proposal, the worker would owe back the amount of the worker’s
payroll taxes that had been deposited in a private account plus an interest
charge set at 2.7 percent per year above the inflation rate (or about 5.5
percent per year overall).[13]
A “benefit offset” would be used to collect these loan repayments — the worker
would repay Social Security by having his or her Social Security benefits
reduced each month in retirement for as long as the worker lived. The amount of
the monthly benefit reduction would be set equal to the amount that the worker
would have to pay Social Security each month to pay off his or her debt if the
worker lived to an average life expectancy.
As a
result, if the investments a worker made with the funds in his or her account,
on average, earned less than 2.7 percent a year above the inflation rate
(i.e., less than about 5.5 percent per year overall), the worker would come out
behind. The amount that the worker would lose in Social Security benefit
reductions (assuming the worker lived to an average life expectancy) would
exceed the value of the account.
On the
other hand, if the investments that a worker made with his or her private
account earned more than 5.5 percent per year on average, the worker
would come out ahead. The worker’s net gain would be the portion of the return
that exceeded 5.5 percent.
Research by noted financial
market expert Robert Shiller, the author of Irrational Exuberance,
indicates that a substantial percentage of workers would likely come out behind
under this arrangement and lose money as a result of having elected a private
account. Shiller’s research suggests that a significant portion of workers
would be expected to earn less than an average of 5.5 percent per year on their
accounts. Their accounts consequently would not make up for the Social Security
benefit reductions to which the workers would be subject as a result of having
elected an account.[14]
With this background, we
now turn back to the issue of how private-account plans would affect
inheritances. Under most private-account plans, including the President’s plan
and the DeMint and McCrery plans, the “benefit offset” would be applied not only
to the Social Security retirement benefits of workers who had elected an account
but also to the Social Security retirement benefits of spouses who inherited an
account if the worker to whom they were married died before retiring.
(Children or other heirs of a worker who died without a surviving spouse
would inherit the account without being required to pay the “benefit offset.”)
Suppose a
worker died at age 55 and the total contributions that he had made to his
account, compounded at a rate set 2.7 percent above inflation (about 5.5 percent
overall), equaled $100,000. Under the President’s plan, he would owe $100,000
back to Social Security. If he had lived, this amount would have been collected
by reducing his Social Security retirement benefits each month. Now that he has
died, his spouse would inherit both his private account and his
$100,000 debt to Social Security. The debt would be collected by
reducing the spouse’s Social Security retirement benefits when she
retired, regardless of whether she had signed up for a private account herself.
As a
consequence, the spouse would come out ahead as a result of inheriting her
deceased husband’s account only if the investments in his account performed well
enough for the account to have more than $100,000 in it.
-
If there was $120,000 in his account, the spouse would come out
ahead by $20,000. But if the deceased worker’s investments did not do well and
earned an average rate of return below about 5.5 percent, the spouse would come
out behind.
-
Suppose the account earned less than 5.5 percent on average and
had $80,000 in it. The spouse would still owe $100,000 back to Social Security;
she would be subject to reductions of $100,000 in her monthly Social Security
benefits over the course of her retirement, assuming she lived to an average
life expectancy. She would come out $20,000 behind. Stated another way, her
inheritance from her deceased husband’s private account would effectively be a
negative $20,000.
Even if
she came out ahead, her “inheritance benefit” would be much smaller than many
private-account proponents imply. In the case in which the account performed
well and had $120,000 in it, many private-account advocates would portray the
spouse’s inheritance benefit as being $120,000. In fact, it would be $20,000.
The
inheritance benefits thus would be based on risk. They would depend on how a
deceased worker’s private-account investments fared in the stock and bond
markets. This would reflect a major shift, from Social Security benefits that
are free of market risk to a private account that is subject to market risk.
A final important point is that
private-account plans that would operate in this manner would produce
inheritances from private accounts that the public would likely regard as
extremely unfair. A widow whose husband died just before he began
collecting Social Security retirement benefits would inherit both her deceased
husband’s account and the debt that he owed to Social Security. She might end
up behind. But another widow whose husband died just after he began
collecting retirement benefits might inherit her husband’s account without inheriting any of his debt to Social Security. If her Social Security
retirement benefit was based on her own work history, she would get his account
without being subject to the “benefit offset.” Even though the deaths of the
two husbands in this example could occur just a few months apart, the
differences for the widows would be very substantial. For example, assuming the
deceased workers were average earners scheduled to retire in 2045, there would
be a difference of about $100,000 in the value of the private accounts passed on
to their widows. This makes little sense as public policy and would likely be
perceived by the public as inequitable and unacceptable.
3. Heirs of
Retirees Who Live to a Very Old Age
A third group of surviving
family members whose inheritances could be reduced under private-accounts plans
are relatives of retirees who elect a private account and then live to a very
old age. Retirees in those circumstances could lose money as a result of a
private account and be left with less money on which to live. As a result,
they may deplete other savings to a greater degree and have less to pass on to
their heirs, or they may need younger family members to contribute more to help
support them in old age.
A fundamental principle of
Social Security is that it helps to insure retirees against the possibility of
outliving their assets. It does this by providing an inflation-adjusted
retirement benefit that lasts as long as a retiree lives. The current
system consequently provides more in total benefits to people who live to a very
old age, since it pays benefits to these people for more years.
A private
account, by contrast, would not provide more in total benefits to a
retiree who lives for many years than to a retiree who lives only a few years,
unless the account has been converted to a life-long annuity. A private account
contains a fixed amount of money. Unlike Social Security, it can run out for
someone who lives to a very old age. (Most private-account plans would require
their participants to annuitize a portion of their account, usually
enough to provide income in old age equal to the poverty line or slightly more
than the poverty line. No major private accounts plan proposed by the President
or a member of Congress would require participants to annuitize most or all of
their accounts.[15])
Annuities,
Private Accounts, and Inheritances
A retiree could elect to convert his or her
private account to a life-long annuity when he or she retired and
thereby avoid a penalty for living too long. However, if an individual
fully annuitized his or her accounts, there would be no
inheritance benefit from the account. For this reason, private-account
advocates who tout the supposed inheritance benefits of such accounts
typically emphasize scenarios in which retirees do not annuitize
their accounts.
Moreover, most private-account proposals
would not require full (as distinguished from partial) annuitization of
accounts. Given the limited degree to which retirees currently purchase
annuities with their retirement savings, it is likely that most retirees
would not annuitize much of their private accounts. If so, they and
their heirs could suffer the consequences if they lived well beyond the
average life expectancy.
Retirees who had a shorter-than-average
life expectancy would benefit from not annuitizing their
accounts. Even so, failing to annuitize often represents a risky
tradeoff. Without annuitization, people who end up living for a very
long time, and consequently need more total resources over the course of
their old age, can find themselves in difficult financial straits in the
final years of their lives. |
There are two key factors here. First, as just noted, private accounts could
not provide more in benefits to long-lived retirees than to other retirees
unless the accounts had been annuitized. Second, most private-account proposals
would require longer-lived retirees to undergo larger Social Security benefit
reductions. This would occur because the Social Security benefits of
workers who elected private accounts would be reduced every month for as long
as the workers lived. The monthly Social Security benefits of retirees who
lived to an older age thus would be reduced for more years than would the
benefits of retirees who died sooner, and the long-lived retirees consequently
would be subject to greater overall benefit reductions. (Note: the amount that
a worker’s monthly Social Security benefits would be reduced each month to pay
back Social Security would be based on the assumption that the worker would live
to an average life expectancy for a retiree. If the worker lived to an
older age than that, the worker’s Social Security benefits would be reduced for
more months than it would take to pay Social Security back.)
Long-lived retirees consequently would be at greater risk than other retirees of
seeing their Social Security benefits reduced by more than the amounts
they had accumulated in their private accounts. To the extent that long-lived
retirees were made worse off by private accounts, they would have less money to
support themselves in old age.
Some retirees who found themselves in this situation would respond to the loss
of income in old age by going more deeply into their savings. That, in turn,
would reduce the size of the inheritances they could pass on to their heirs.
Other
very long-lived retirees — particularly those with less money, who might not
have been able to leave much, if any, inheritance anyway — might have to rely
more heavily on family members for financial support in old age in order to make
up for the loss in income they would have suffered by electing a private account
and then living to a very old age. These individuals would essentially leave a
larger negative inheritance to their relatives as a result of the private
accounts. In both types of cases, private accounts would have left heirs worse
off.
Heirs of individuals who died soon after retiring, and well before reaching the
average life expectancies for a retiree, would face the reverse situation. In
these cases, the deceased worker would not have lived long enough to pay back
Social Security for the private account, and surviving family members generally
would be able to inherit the account without having to pay back the remainder of
the deceased worker’s debt to the Social Security system. If the deceased
worker had neither fully annuitized the account nor spent most of the funds in
the account before dying, the surviving members would generally receive larger
inheritances as a result of the private accounts.
III. A Retiree’s
Consumption Versus an Heir’s Inheritance
Previous sections of this
paper have examined situations in which heirs would end up worse off under
private-account plans. For many other retirees, private accounts would
make little difference in how much their heirs inherited.
For
retirees who live to about an average life expectancy, private accounts would
offer essentially the same tradeoff as retirees face today in the absence of
private accounts: retirees could leave a nest egg for their heirs, but to do so,
they would have to sacrifice some of their own consumption in old age.
Retirees can use their resources either to consume for themselves or to save for
heirs. If private-account plans provide retirees with the same overall level of
resources as a system without private accounts (as would generally be the case
for people who live to about an average life expectancy for retirees), then the
choice will remain essentially the same for retirees, irrespective of the form
in which the money comes. A monthly Social Security check can either be spent
or saved for an inheritance. The same goes for a lump-sum payment or monthly
income from a private account.
Accordingly, retirees with private accounts would face similar decisions to
those that retirees face under the current system. Under both systems, retirees
would have to decide to what degree to spend to meet current needs and to what
degree to save for heirs.
IV. Negative
Effects on Social Security Solvency
Under most private-account plans, including the President’s plan and the DeMint
and McCrery plans, private accounts would essentially be treated as a loan from
the government that would be repaid by reducing the account-owner’s Social
Security benefits in retirement. As long as the loans are paid back in full,
long-term Social Security solvency would not be affected. If, however, the
loans are not paid back fully, the Social Security shortfall would be
enlarged, necessitating deeper Social Security benefit cuts or greater payroll
tax increases to bring the system into long-term financial balance.
As this analysis explains, the reduction in Social Security benefits to which
workers who elect private accounts would be subject under most private-account
plans would be calculated so that a worker’s debt would be fully repaid if the
worker lived to an average life expectancy. Retirees who lived to a very old
age would pay back more than their debt, while those who died shortly
after retiring would pay back only a portion of their debt. From the standpoint
of Social Security solvency, the effects from these two groups of retirees
(those who lived to a very old age and those who died soon after retiring) would
largely offset each other, leaving long-term solvency essentially unaffected.
There would, however, be another group of workers — those who died
before
and who did not have a surviving spouse. Under the Bush, DeMint, McCrery, and
other private-account plans, the entire account would be passed to heirs in
these cases, with none of the debt to Social Security being repaid.
Social Security
Could be Changed to Provide
Comparable Inheritance Benefits to Private Accounts
If a worker dies only a few years into
retirement, he or she will receive relatively few retirement benefits from
Social Security. The worker will not be able to save and then pass to
heirs the Social Security benefits that he or she would have received if
the worker had lived longer.
If policyworkers wished to do so, they
could modify the current Social Security system to provide the same
“inheritance benefit” in such circumstances that private-account
proponents trumpet, without converting part of Social Security to
private accounts. As with private accounts, however, doing so would
come at the expense of people who live longer in retirement and would
represent dubious policy.
The Trade-off: A Guaranteed Life-long
Benefit Versus
A Lump-sum Payment at Retirement
Specifically, Social Security could be
changed so retirees could collect a portion of their benefits as a lump
sum at retirement, in exchange for receiving a reduced annual benefit for
the rest of their lives. If this exchange were designed so it was
actuarially neutral, it would not affect Social Security’s long-run
solvency.
For example, under current law, an average
earner who retires in 2005 at age 65 would receive an annual Social
Security benefit of $14,830. Under this change to Social Security, such a
worker could take a portion of his or her annual benefit as a lump sum;
for example, the worker could collect a poverty-level annual benefit of
$9,250 per year, plus a $72,060 lump sum, instead of a $14,830 annual
Social Security benefit. The worker would accept a reduction of $5,580 a
year in benefits for as long as he or she lived in return for the lump-sum
payment.
The retiree could spend the lump sum as he
or she chose. The worker could spend the amount quickly on a new house or
an around-the-world cruise, spend it down slowly as a supplement to his or
her monthly Social Security check, or leave it to his or her heirs.
Why This Would Not Be a Sound Idea
If the worker died soon after retirement,
he or she would come out ahead under this option, because the worker would
have gotten either to spend the lump sum amount or to leave it to heirs.
If the worker lived for 30 years in retirement, however, the worker would
be much worse off as a result of having received the lump-sum payment.
The total value of the worker’s Social Security benefits would be
substantially less than under current law, because the worker would lose
$5,580 in Social Security benefit every year for 30 years. In addition,
there would be serious risk that the worker would eventually exhaust all
of his or her other assets and be left in very old age with nothing more
than a Social Security benefit that had been reduced to the poverty line.
In short, the lump-sum payment that could
be passed on to heirs would be financed by eroding one of the major forms
of insurance that Social Security provides — insurance against living a
very long life.
Private accounts entail the same tradeoff.
They would provide expanded choices to retirees but would do so in return
for substantial reductions in annual Social Security benefits — and less
insurance against a retiree having to reduce his or her living standards
and facing difficult straits in very old age
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Heirs would receive significant inheritances in these circumstances. The Social
Security Trust Fund, however, would never recoup the loan it had made to the
worker whose account was passed on to heirs. The increased inheritance these
heirs would receive would not come for free. It would come at the expense of
Social Security solvency.
Because of such
situations, the Social Security Trust Fund would likely incur a net long-term
loss as a result of most private account plans, with the net loss enlarging the
Social Security shortfall. That, in turn, would necessitate deeper Social
Security benefit cuts or larger tax increases to restore long-term solvency.
As
economists like to say, “there is no such thing as a free lunch.” If the net
effect of private accounts is to increase inheritances overall, then private
accounts will enlarge the Social Security shortfall in so doing. (The money to
pay for the increased inheritances must come from somewhere, and under most
private account plans, these funds would come directly from the Social Security
Trust Fund.) Moreover, even if the total amount passed on to heirs increased,
many individuals' inheritances would shrink, as this analysis explains,
and many of the people who ended up with smaller inheritances would be the
people who most need adequate resources to make ends meet.
V. Conclusion
Private-account advocates
frequently promote accounts as a way to allow workers and retirees to pass
Social Security benefits on to heirs. As this analysis demonstrates, however,
private accounts offer a false promise to many heirs.
Many private-account plans,
including the President’s, feature proposals to scale back Social Security
benefits substantially, including survivors benefits. Such proposals would
harm some of the most vulnerable survivors, including minor children, adult
children with disabilities, and elderly widows. For many of these
survivors, the additional money, if any, that they would receive by inheriting a
private account would make up for only a modest fraction of the survivors
benefits they would lose.
In addition, spouses of workers
who died before retirement would inherit not only the deceased worker’s account
but also the debt that the worker owed to Social Security for having set up the
account. If the deceased worker’s account did not produce earnings averaging
about 5.5 percent per year (under the President’s plan), the debt would exceed
the value of the account, and the net inheritance the spouse would receive would
be negative.
Private-account plans also would
be detrimental to the heirs of many retirees who lived to a very old age. Such
retirees often would lose more, through the offsetting Social Security benefit
reductions to which they would be subject, than they would gain from the
accounts. To the extent that such retirees depleted more of their savings in
old age because they had less income as a result of having elected an account,
they would have fewer assets left to pass on to heirs. For other heirs, such as
the heirs of retirees who fully annuitized their accounts and the heirs of
retirees who lived to about an average life expectancy, there generally would be
little or no change in the amounts that they inherited.
To be
sure, some heirs would come out ahead. In many cases, however, their additional
inheritance benefits would come at the expense of the Social Security Trust Fund
— and ultimately would have to be financed primarily through deeper Social
Security benefit reductions or larger tax increases. Furthermore, unlike Social
Security survivors benefits, any increased “inheritance benefits” that resulted
from private accounts would not be targeted effectively on people who were most
in need of financial support after the death of a spouse or a parent.
Lastly, this analysis
suggests that seeking to expand inheritance benefits by making changes in the
Social Security system — whether by replacing part of Social Security with
private accounts or by altering Social Security to offer lump-sum payments at
retirement — would be ill-advised. Expanding inheritance benefits in either of
these ways would make the Social Security shortfall larger, result in
substantial numbers of seniors being poorer in very old age, or both. Other
mechanisms to strengthen retirement security and inheritances — such as
improvements in the private pension system so that more workers can participate
in it and save more for their retirement — would constitute much sounder and
less risky ways to pursue this goal.
The difference between
the average rate of return on stocks and the average rate of return on bonds is
known as the “risk premium.” Most policy analysts — including the Congressional
Budget Office — subtract the risk premium when projecting the returns on a
portfolio. That produces what is known as a “risk-adjusted” rate of return.
The rate of return assumed here uses the same risk-adjusted methodology that CBO
uses in its analyses of Social Security plans.
Assuming a higher rate of return on private accounts
would not substantially affect the results in this example. The worker in
this example dies at an early age, so the account would have accrued interest
for only a few years at that point. Under the intermediate assumptions of
the Social Security actuaries, private accounts would earn an average rate of
return of 4.6 percent above inflation, without adjusting for risk. At that
rate of return, the account of a worker with average earnings who dies in 2045
after contributing to the account for ten years would be worth $2,100 more than
if the account had earned a 3.0 percent real rate of return, as assumed above.
At the higher rate of return, a reduction in survivors benefits from the
sliding-scale benefit reductions would still far surpass the size of the private
account. The surviving family members would be worse off by $97,600, as
compared to how they would do under the current system.
End Notes:
[1]
Social Security also pays survivors benefits to adult children with
disabilities who become disabled before age 22 and to a spouse if she is
raising a child of any age who has a disability, or if the spouse herself has
a disability and is at least 50 years old.
[2]
Private accounts would not have this problem if they required participants to
fully annuitize their account balances at retirement. No private-account plan
that has been proposed by the President or a Member of Congress, however, has
included such a provision. To the contrary, all of those plans emphasize that
full annunitization would not be required and that account-holders
would have choices regarding the use of funds in the accounts.
[3] There are two situations in which this could
occur. The first would take place when a worker died before or shortly
after retiring and had no surviving spouse. Under private-accounts
plans, only the surviving spouse, and not any other heirs, can be assigned the
responsibility of repaying the debt to Social Security. The second situation
in which an heir would come out well ahead would occur when a worker died
shortly after retiring and his spouse’s Social Security benefits
were based on her own earnings record rather than the deceased worker’s
record. In both situations, little or nothing would have been withdrawn from
the account before the worker died, and the amount that remained would be
passed on to heirs without a companion obligation to repay Social Security.
[4]
Social Security Administration, 2005 Social Security Trustees Report,
March 2005, Table III.A5.
[5]
This is the number of beneficiaries who received survivors insurance in
November 2005. The 1.9 million children receiving survivors benefits included
1.3 million children under age 18, some 508,000 adult disabled children, and
54,000 children age 18 who are full-time high school students. Social
Security Administration, OASDI Monthly Statistics, November 2005,
Tables 4 and 6.
[6]
Specifically, survivors benefits are paid to surviving children under age 18
(or under age 19, if the child is a full-time high school student); surviving
adult children with disabilities (if the children become disabled before age
22); a widow at any age with a dependent child who is either under age 16 or
disabled; disabled widows age 50 and over; elderly widows age 60 and over; and
dependent parents age 62 and over.
[7]
In this example, the actuaries assume that one child is a new-born, the second
child is age two, and the widow is age 27 and does not work. The actuaries
also assume that the deceased worker was a steady average earner. The total
includes the value of benefits paid to both the children and the spouse. The
value of the benefits is expressed in present-value terms. (The present-value
measurement is the standard way of presenting financial transactions occurring
over long periods of time. A dollar in the future is worth less than a dollar
today. The present-value calculation takes this “time value” of money into
account.) Office of the Social Security Chief Actuary, “Present Values of
Expected Survivor and Disability Benefits for an Illustrative Case,” 2001.
[[8]
Most widows in this group are widows whose husbands have died before starting
to collect Social Security retirement benefits and who themselves live to an
average life expectancy or longer. (Note: If a worker dies after
starting to collect Social Security retirement benefits, and the widow’s
Social Security retirement benefits are based on her own earnings record
rather than her husband’s, she would inherit what remained in his account
without having to repay what remained of his debt. However, if the worker
died after retiring but the spouse’s Social Security benefits were based on
her deceased husband’s earnings record rather than her own, she would
be responsible for repaying his debt.) These complexities, and the
potentially large differences in the inheritance benefits that would go to the
heirs of otherwise similar workers who died only a few weeks or months apart,
represent an additional problem associated with private-account plans.
[9]
The benefit reductions would escalate sharply in size as the deceased worker’s
average earnings rose above $20,000, until the worker’s average earnings
reached $90,000. The benefit reductions would be the same for the survivors
of people who earned an average of $90,000 as for the survivors of people who
earned larger amounts.
[10]
The $124,800 and $270,100 figures are expressed in net present value. They
represent the amount of money that a family would have to set aside in the
year that it started collecting benefits in order to make up, with interest,
for the benefit reductions to which it would be subject. (These estimates
assume that the deceased workers were steady average earners. This is the
same assumption as is used by the Social Security actuaries in making a
similar calculation.)
[11]
For more details, see Jason Furman, “New White House Document Shows That Many
Low-Income Beneficiaries Would Face Benefit Cuts,” Center on Budget and Policy
Priorities, May 10, 2005, available at
https://www.cbpp.org/5-10-05socsec2.htm.
[12]
The value of the private account is calculated assuming a “risk-adjusted” rate
of return on the private account of 3.0 percent above inflation. Over time,
Treasury bonds are expected to earn a 3.0 percent real rate of return.
Although equities would be expected to earn a higher average rate of return,
that is because equities are more volatile and involve higher risk. Investors demand to be compensated for this additional risk. In other
words, since investments in stocks are riskier and can lose more money,
average returns on stocks have to be higher over time or else few would be
willing to invest in them.
[13]
The DeMint and McCrery plans are very similar.. Under these plans, the Social
Security benefits of a worker who elected a private account would be reduced
by the amount that the worker had contributed to the account, plus an interest
charge set 0.3 percent below the Treasury bill rate. Under the long-term
economic assumptions of the Social Security actuaries, this interest charge
would be equivalent to a fixed interest charge of 2.7 percent, which is the
same as in the President’s plan.
[14]
Robert Shiller, “Life Cycle Portfolios as Government Policy,” Economist’s
Voice Volume 2:1, http://www.bepress.com/ev/vol2/iss1/art14.
[15]
An exception is a recent plan proposed by Jeffrey Liebman, Maya MacGuineas and
Andrew Samwick.
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